Sunday, February 12, 2006

The US Economy and Markets May Be Heading For A Bernanke 'Trap'

Rob Lee

..."8. The trap is further deepened by the unfortunate reputation that Mr Bernanke has generated for himself. The following is an well known extract from a speech Mr Bernanke gave in November 2002:

"Like gold, U.S dollars have value only to the extent that they are strictly limited in supply. But the US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S dollars at it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate... inflation."

It should be emphasised that this was no off the cuff remark, but contained in a set speech while he was already a Fed governor. He has repeatedly expressed these and similar views since. Of course his analysis may very well be correct, but it was not wise of a potential future Fed Chairman to say so. Central bankers around the world were privately aghast. Let's face it, the sobriquet "Helicopter Ben" is not helpful to the man now in charge of the world's reserve currency. Mr Bernanke must be well aware that he has this reputation for being weak on inflation. Is it likely that his first move as Chairman will be to ease policy? No. Does he have less room for manoeuvre than Mr Greenspan, both within the Fed and with markets? Yes.

In summary, I think the US economy is already slowing significantly. Monetary policy is tighter than it appears. Mr Bernanke's Fed will (partly inadvertently) tighten policy even further and initially be slow to react"